Tesco aims higher after cementing recovery

By James Davey and Paul Sandle

LONDON (Reuters) - Tesco (TSCO.L), Britain's biggest retailer, reported strong first half results and showed confidence it could build on its recovery by setting tougher profitability targets, sending its shares as much as 14 percent higher.

Chief Executive Dave Lewis, who took charge two years ago when the supermarket group was mired in crisis, said on Wednesday he wanted to pick up the pace despite falling food prices and intense competition.

"We feel extremely stable and now is a time for us to move on, to step it up," he told reporters.

Lewis plans to cut costs further and plough the savings back into the business to boost profit over the next three years.

He is targeting a group operating margin of between 3.5 percent and 4.0 percent by the 2019-20 financial year. That is well ahead of a figure of 2.18 percent for the first half of the current 2016-17 year.

Shares in the group hit a 13-month high, while rivals Sainsbury's (SBRY.L) and Morrisons (MRW.L) also advanced. Tesco stock traded 10.8 percent higher at 209.10 pence at 1440 GMT. They were 230 pence when Lewis joined in Sept. 2014.

Lewis said his confidence was based on the group now being competitive after having cut prices by an average 6 percent over two years and achieving seven straight quarters of volume growth in Britain.

He also pointed to the success of the major investment in "Farm Brands" - a range of own label fresh produce, poultry and meat -- and by data showing shoppers were now abandoning competitors to return to Tesco.

"Perhaps there is a glimmer of light at the end of the tunnel after all," said Richard Hunter, head of research at Wilson King Investment Management

"The generally upbeat feel to these numbers is capped off by an ambitious operating margin target, which...would be particularly hard won in such a fiercely competitive industry," said Hunter, whose firm is not an investor in Tesco.

LEWIS CONFIDENCE

Hopes are rising among investors that Britain's established supermarkets can succeed in fighting back against the privately owned German discounters Aldi and Lidl, who have rapidly built up market share in recent years.

Tesco, which remains clear leader with a 28 percent share of the British grocery market, reported first half profit at the top end of analysts' expectations.

Lewis has been leading a recovery after sales, profit and asset values were hammered by changing shopping habits, the rise of the discounters and an accounting scandal that remains the subject of a criminal investigation by Britain's Serious Fraud Office.

Lewis did, however, note the UK market remained "tough and uncertain", with deflation persisting.

"Despite that toughness we're confident that at Tesco we're competitive and we ought to be able to deal with those conditions at least as well, if not better, than many others in the market," he said.

Tesco plans to reduce its operating costs by a further 1.5 billion pounds over three years through efficiencies in its distribution network and stores and from procurement savings. It would step up capital expenditure to 1.4 billion pounds a year to support the programme.

PENSION CLOUD

Chief Financial Officer Alan Stewart said it was too early to talk about the resumption of a dividend, which has not been paid since the second half of the 2014-15 year.

Tesco, however, said it would not increase the size of its annual 270 million pound pension top-up payments agreed with trustees last year, despite its deficit jumping to 5.9 billion pounds, from 2.6 billion pounds in February, due to the collapse in bond yields in the wake of Britain's vote to leave the European Union.

Though Tesco faces a triennial pension valuation exercise next March, Stewart played down concerns, noting several options in the agreement with trustees, including changing the number of years it is due to make annual payments.

Tesco reported a 60 percent rise in operating profit before one off items of 596 million pounds for the six months to Aug. 27. It said it was on track for profit of 1.2 billion pounds for the full year, broadly in line with market expectations.

(Additional reporting by Sarah Young, Kate Holton and Emma Thomasson, editing by Keith Weir)